Tenant Damage Deters Many Would Be Investors
Posted on March 23, 2007
Has the fear of tenants trashing a property kept you from investing in rental real estate? If so, you’re not alone. A week seldom passes without someone approaching me to say that they would like to buy a rental property, but their brother, sister, uncle, cousin, nephew, friend, co-worker or someone else they knew told them about a house they once owned that the tenants practically destroyed. When I would ask if they knew people who had been very successful owning rental properties, invariably they would acknowledge they had, but not very many.
I recently received an email from a long time landlord who asked, “How do you handle renters when you check on a property and see that they are doing damage?” Her concern was that once damage is done, it seems like all you can do is get a judgment that is difficult, if not impossible, to collect. Her concern is valid and it speaks volumes about the importance of carefully screening tenants before turning your property over to them.
I’ll discuss ways to protect you from loss a bit later, but before doing so I want to point out why I’m a strong advocate for using property managers to handle my rentals. Most professional property managers are licensed, insured and required to take continuing education courses in landlord/tenant law and other aspects of property management. They have a pool of subcontractors on standby to handle maintenance issues and furnish owners with monthly or quarterly accountings of all income and expenses related to their properties.
In addition to these expected tasks, one of the most important functions of a good manager is proper screening of prospective tenants before renting to them. This usually entails having them fill out a detailed rental application and paying an application fee to cover the cost of obtaining credit and criminal history reports. This doesn’t guarantee a tenant won’t damage the property or stiff you on the rent, but is sure eliminates many of the known prior offenders. Those with a history of being bad tenants aren’t willing to pay the application fee, which is non-refundable, because they know they will be turned down.
These bad tenants often look for naive individuals trying to manage their own properties in hopes that they won’t check credit and criminal histories. Most of them are great at making good first impressions and they know their current landlord will probably give them a good reference just to get rid of them. My experience is that most of the brothers, sisters, uncles, cousins, nephews, friends, co-workers and others who report tenant problems frequently fall into this category and there’s a reason why. They probably paid too much for the properties and couldn’t afford to pay for professional management.
With that said, the truth is, there is no way to guarantee that you won’t occasionally get a bad tenant. If you’re in the business long enough, no matter how well you screen, you’re going to get a tenant who damages the property. This is as much a normal expense for real estate investors as shop lifting or employee pilferage is for a retail store owner. It’s when an expense is unanticipated and you’re not prepared for it that it becomes a big problem.
Many new investors buy properties thinking that if the rent will cover the mortgage payment, taxes and insurance they’ve gotten a good deal. Wrong! Management and maintenance are real expenses that either have to be paid in cash or performed by the owner. Personally I never liked to work for FREE.
Maintenance is the expense that gets most new investors. In my book The Weekend Millionaire’s Secrets to Investing in Real Estate, (McGraw-Hill 2003) I talk a lot about “maintenance reserve.” The reason I call it reserve is because it doesn’t necessarily happen on a regular basis. As long as you own a property, the roof, appliances, heat and air conditioning systems, carpets, paint and other items are wearing out. Oh yes, the occasional bad tenant will do damage too! Unless you plan for these expenses before they arise, its easy to get caught is a financial dilemma if you’re suddenly faced with several thousand dollars in expenses and no money to pay them.
Here’s a tip! When you’re evaluating whether or not to purchase a rental property, estimate the amount of rent the property will bring in and then subtract from it an allowance for vacancy, which will occur between tenants, a fee for management, taxes, insurance, other known expenses plus a reserve for maintenance. Then see if you can structure financing that will allow you to buy the property with what’s left over. If you can’t, don’t buy it unless you want to pay for the privilege of owning it.
Just be sure that you put the maintenance reserve aside in a separate account, if not you may accidentally spend it and not be prepared when a big expense hits. This maintenance reserve should be enough to cover deferred maintenance items plus the occasional tenant damage that will eventually occur. When you approach real estate investing in this manner, you can build wealth with minimum risk.
The secret is having the patience to keep looking and continue making offers until you find properties that can be purchased in this way. Otherwise, you’re not investing, you’re speculating and that may cause you to soon be one of those brothers, sisters, uncles, cousins, nephews, friends, co-workers, etc. with a horror story to tell about your real estate experience.
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